Site Navigation

Site Mobile Navigation

Taxing Electronic Commerce

A Congressional commission, due to report early next year, held inconclusive hearings last week on proposals to tax -- or not tax -- sales conducted over the Internet. The debate is between those like Senator John McCain and other prominent Republicans who want to exempt electronic commerce in whole or in part from sales taxes, and others like the nation's governors who say that an exemption for Internet sales would perniciously undermine their ability to collect taxes. The likely outcome of the commission, as well as in Congress, is for stalemate. But political stalemate could hand the governors a big victory courtesy of the courts.

An elementary principle of taxation says that taxes should distort purchasing decisions as little as possible. It is not the role of a tax code to determine whether customers shop in stores, online or by mail order. But standing in the way of this principle is a Supreme Court decision that prevents states, say New York, from collecting taxes on sales to New Yorkers by companies located in California unless the company has a branch office in New York. That ruling puts in-state stores at a disadvantage and robs state and local governments of billions in sales tax revenues.

So far these problems have been manageable. But the explosive rise of electronic commerce threatens to turn a leak into a flood. Efforts to exempt Internet sales entirely would make matters worse still. Some proposals would even allow in-state stores to avoid local sales taxes by entering a customer's order over the Internet. The threat is that local governments would then be forced to cut back spending or raise taxes on captive audiences. These countermeasures could prove punishing for low-income families too poor or unsophisticated to buy home computers for online access.

One plan sponsored by the nation's governors appears naive at first glance, but it could lead to new court decisions. The governors envision new software that would make it easy for Internet-based companies to calculate sales taxes, no matter in which of 6,500 or so jurisdictions their customers live. The governors hope that e-commerce companies would then volunteer to start collecting taxes because the task would no longer be onerous. It does, indeed, seem fanciful to expect businesses to collect taxes they do not have to charge. But what starts off voluntary might not remain so.

The Supreme Court did not say that it would prevent states from collecting sales taxes from out-of-state companies forever. It pointed to the fact that at the time of its decision there was no feasible system for imposing that burden on the out-of-state businesses. If, as promised, the governors provide e-commerce companies with software that calculates the right tax no matter where the buyer lives and sets up an authority to distribute the money, then the courts might decide that collecting sales taxes no longer constitutes an excessive burden.

Democrats and Republicans, liberals and conservatives can carry on an honorable fight over how much tax Americans should pay. But there is no principled reason that Congress, under the guise of promoting electronic commerce, should undermine the ability of state and local governments to collect taxes. If people want to shop online, they will do so without any artificial boost from Congress.